For many Canadians, the annual exercise of taking the calendar off the nail on the wall and replacing it on January 1 is synonymous with a few other things. Some take the opportunity to change the batteries in the smoke detector, while others rotate the aging bottles of wine in their storage lockers. These actions provide long-term benefits.
There is one thing that no Canadian should ever overlook.
For many, the turn of the New Year translates to something much more financially driven: an annual Tax-Free Savings Account (TFSA) contribution. As a reminder, the annual TFSA contribution limit is $5,500, which can be added to the account at any time. The benefit to making the contribution earlier rather than later in the year is being able to grow the money in the account completely tax free instead of investing it in a taxable account and having to pay taxes on the gains achieved throughout the year.
We’re currently halfway through the year. Many Canadians have yet to make any contributions to their TFSAs, while others are making monthly contributions that will add up over time. The good news is that there is still six months of gains that can be sheltered for every Canadian with a TFSA.
With the ability to shelter interest income, dividends, and capital gains, there are a number of options available to Canadians. Taking the shares of Canada’s most profitable companies, which are the Big Five banks, investors have the opportunity to purchase shares without worrying about the tax consequences.
During the first half of the year, shareholders of Royal Bank of Canada (TSX:RY)(NYSE:RY) saw price appreciation in the amount of 3.6% and received dividends totaling $1.70, which roughly translates to a yield of 1.8% (3.6% annualized). In this circumstance, the total return inside the TFSA was 5.4%. Had the investment been subject to tax, then the net (after-tax) return would have been substantially less.
Depending on the rate of tax of the individual, the net return could have been closer to 4% — potentially a little more or a little less. As a long-term investor, it is essential to understand the importance of compounding and how paying unnecessary taxes can bear a very high cost over a long period of time. Remember, compounding one’s money is transparent. Compounding the monies lost to taxes is much more difficult to calculate.
With half the year behind us, now is a fantastic time to consider the status of our TFSAs.
